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I occasionally participate in webcasts, taking questions from Vanguard investors on various financial topics. Almost invariably, someone asks about reverse mortgages. Should they or shouldn’t they? How do they work? And are they legitimate?

Last question first: Yes, reverse mortgages are legitimate, and they seem to be gaining in popularity. But it’s clear that as with any financial decision, opting for a reverse mortgage requires some homework. You will want to understand not only the provisions and payment stream but also the upfront and continuing costs.

A reverse mortgage is a loan made to a homeowner using all or part of the home’s equity as collateral. For the most popular type of reverse mortgage in the United States—through the Federal Housing Administration’s Home Equity Conversion Mortgage (FHA HECM) program—the amount of the loan is generally computed via a formula that takes into account the age of the owner(s), the appraised value of the home, and the prevailing interest rate environment. There is no repayment schedule, and no income or credit requirements. Payments are made to the homeowners in a lump sum, monthly installments, or even through a line of credit. The homeowners are still responsible for real estate taxes, maintenance, insurance, and utilities. The loan is repaid when the last surviving homeowner permanently moves out (or dies). Any equity remaining after the loan obligation is satisfied flows to the owners’ heirs.

In January 2009, the U.S. Department of Housing and Urban Development introduced a federally insured reverse mortgage program, HECM for Purchase, that allows seniors to apply for a reverse mortgage for the purchase of a new principal place of residence.

Not surprisingly, there are a bunch of complicated rules, and not all financial institutions participate in the program. But it may be worth checking out if you’re 62 or older and are thinking about selling your home to head for a warmer clime or a smaller residence, or maybe to be closer to the grandchildren.

There are no limitations on income, assets, or the value of the home being purchased. As with the original HECM program, the amount you can borrow is limited by a formula derived from the home’s appraised value or the FHA HECM mortgage limit (currently $625,500), whichever is lower. You can even finance your closing costs, though that would lower the amount of money you receive.

In essence, this type of reverse mortgage is actually a mortgage with delayed repayment. Lenders recover their principal and interest when the home is sold or you stop occupying it as your principal place of residence, and any remaining value goes to your heirs. If the sales proceeds are insufficient to satisfy the loan obligation on any HECM loan, the FHA will pay the shortfall; one of the program’s expenses is an insurance premium of 2% upfront plus 0.5% annually. Again—lots of rules, but it just might fit for you.

Have you or someone in your family taken a reverse mortgage? Are you considering it? If so, let me know. I’d love to hear about your experience.

Note: The information provided here is for educational purposes only and is not intended to be construed as legal or tax advice.

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Ellen Rinaldi

Ellen is a leader in Vanguard Planning and Development Division, where she oversees security measures that protect client and fund information. She joined Vanguard in 1997 and previously led our advice department and oversaw our investment counseling and research team. Prior to joining Vanguard, Ellen spent 20 years in the insurance industry. Ellen earned a B.A. from the University of Connecticut, a J.D. from Suffolk University, and a master of laws (LL.M.) from Boston University.

Comments

Anonymous | February 22, 2013 6:31 pm

We have a reverse mortgage. Fortunately, we did not really need it, but though we would get it and spend money from there rather than touch our investments. Not really happy with it because we did not actually ever use it. We paid a $20,000 fee to set it up. That fee keeps compounding due to monthly interest charges and other monthly fees maintenance fees. So, we have a $20,000 debt that keeps growing and we have not used it. I would not recommend it unless it is really needed. We know we do not have to pay it back until we sell our home. However, I have started to pay it back because it just keeps growing. I will get it down to about $50.00, eventually. Then the interest per month will be lower. Since we already have it….it will be a back-up for us, but at a much lower monthly cost.

Anonymous | June 1, 2012 9:44 pm

I’ve done some research on the HCEM’s. There are calculators on-line, but the sites that have them are aggressive in pursuing your business, which must reflect their interest in the high transaction costs. I’m not sure, in that regard, if the interest on the loan simple interest, or if it is compounded on the growing balance. I suspect the latter, which would account for a lot of the transaction costs presumably?

Anonymous | August 30, 2010 6:22 pm

I am 69 years old, and have approximately $180,000 in a credit union
money market account. I’ve been looking at homes in that range, since my last home was paid for, and I love the idea of no monthly mortgage. I haven’t found a suitable home in that price range in California, and am considering a home equity conversion purchase to put me in a higher range.
I’ve done considerable research on the HECL’s, and the only part that troubles me thus far is the .5% annnual insurance fee. That’s not .5% of the purchase price is it?
Thank you for your response

Anonymous | July 20, 2010 6:35 pm

A disadvantage of a reverse mortgage are the very high transaction costs and the limits on what your can do with the house after you put the reverse mortgage into effect. A reverse mortgage is a form of immediate annuity. For my mother in her mid-70’s I determined that she could take out a traditional mortgage and use the proceeds to buy an immediate annuity from an insurance company. The immediate annuity would make monthly payments to my mother that would exceed the mortgage payments by a few hundred dollars. Since these are two separate transactions, my mother can do whatever she wants to with the house and she has a lifetime income from the annuity.

Anonymous | February 25, 2010 9:15 am

I have a friend who suggested I , a 68-year-old widow, take out a reverse mortgage on my $1,300,000 home located in a resort area. Then, I could invest in an annuity that would earn more in interest (7.2% supposedly) to cover the costs of the reverse mortgage. Is this even remotely possible? Please comment.

Anonymous | February 22, 2010 1:15 pm

Anonymous | February 21, 2010 10:39 am

Ellen,

A timely topic given our aging baby boomer population…it seems that I see this topic discussed in the media – mainly print and TV – lately. Could the reverse mortgage programs be the next new financial cure-all filled with possibilites and pitfalls? And given the “zeitgeist” of our time, how will regulation, or lack thereof, influence how this program progresses?

Perhaps, Vanguard’s research and analytical departments could further explore the ramifications of this financial strategy for its stakeholders within its vast library of audio podcasts, analytical forecasts, video, and print documents.

Anonymous | February 18, 2010 11:21 pm

I am a person with no spouse or immediate heirs. A reverse mortgage seems to make better sense for this life situation–aside from the risk of discovering you are wanting to move, later. It would help pay for a better retirement, also.

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At Vanguard, we’ve always believed in candid, direct communication with investors. In fact, it’s one of our core principles. In 2009, we created the Vanguard Blog so that we could talk about what’s happening in our industry and in the economy—and hear what’s on the minds of investors like you. More

Visit vanguard.com or contact your broker to obtain a Vanguard ETF or fund prospectus which contains investment objectives, risks, charges, expenses, and other information; read and consider carefully before investing.

Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Investments in bond funds are subject to interest rate, credit, and inflation risk.

Diversification does not ensure a profit or protect against a loss in a declining market.